Current issues in economics

Category Archives: Growth

HT to colleague Paul Chapman for this graphic from ‘Dynamic Graphics’. The Dynamic Graph (Data Visualization) Shows the Top 20 Countries with the Highest GDP PPP from 1980 to 2023. The Ranking includes superpowers, such as United States, China, Japan, India, and Germany. It also compares the total GDP (PPP) of different continents from the Top 20 countries, mostly North America, Europe, and Asia. Interesting to see the rise of China and the changes in top continent by GDP (PPP).

Since the GFC economics has been dominated by fiscal and monetary policies to stimulate aggregate demand. Monetary policy has in particular been reinventing itself with low interest rates not being enough to stimulate demand and the introduction of numerous rounds of QE.

Other policy areas might lack the excitement of delving into the unknown but are just as important to an economy. Maintenance of a country’s infrastructure, assets and government accounts are essential to the long-term development but government’s tend to avoid them as they are not creating anything new and therefore not recognisable by voters. A new hospital, school or major road grab the headlines and inform the electorate that they have been busy putting tax payer money to good use. Maintenance lacks the glamour of innovation.

The US after the GFC did spend a lot of money on new vanity infrastructure projects but these were in sparsely populated areas. However, it was busy cities that really needed their transport infrastructure upgraded and you would think this would be a priority for governments. In the US the fraction of existing road surfaces that are too bumpy has risen from 10% in 1997 to 21% in 2018. Invariably if infrastructure is not maintained it causes significant costs for an economy and in some cases fatalities – the recent bridge collapse in Genoa, Italy. One of the issues for economists is that the typically used measure of an economy, GDP, doesn’t take into consideration the cost of wear and tear. In order to do this they must work out the lifespan of each asset and decide on its depreciation. Some are similar to light bulbs which means they work until they blow – economists refer to this as the “one hoss shay” case. This is based on a poem where it imagines a horse-drawn cart built so well that it never broke down until it eventually fell apart. victim of a “general flavour of mild decay”. Other assets are more linear in how they depreciate in that they lose the same amount each year. Japan assumes that houses lose 4% in value each year and that is why Japan’s consumption of fixed capital is high – 22% of GDP – see graph from The Economist.

Too often governments, and organisations for that matter, preserves day-to-day spending by cutting maintenance and investment. Finance ministers might invest more in maintenance if the resulting boost to public wealth became more transparent. Furthermore if all government departments had to account for all the capital tied up in their operations, they might feel obliged to be more productive with it. New Zealand seems to be the only country to update its public-sector balance-sheet every month, allowing for timely assessment of public-sector worth. So instead of impressing voters with ideas and glossy projects, being boring might actually do some good. Economists tend to be good at this.

Danny Quah of the London School of Economics (LSE) wrote a paper in 2011 describing the dynamics of the global economy’s centre of gravity. By economic centre of gravity he refers to the average location of the planet’s economic activity measured by GDP generated across nearly 700 identifiable locations on the Earth’s surface.

The graphic below from The Economist shows an updated WECG. In 1AD China and India were the world’s largest economies. European industrialisation and America’s rise drew the economic centre of gravity into the Atlantic. However Japan’s economic boom made it the second largest economy in teh world pulling the centre north. As China has regained economic leadership, the centre is now retracing its footsteps towards the east. Extrapolating growth in the 700 locations is projected by 2025 to locate between India and China.

It is interesting to note how the WECG seems to move horizontally so does this suggest that the north-south divide will remain invariant? In looking at the actual data in Quah’s research, it shows that latitude declines from 66 degrees North to 44 degrees North by 2049. This might seem to imply that the south, like the east, is actually gaining considerable relative economic strength. Policy formulation for the entire global economy, and global governance more generally, will no longer be the domain of the last century’s rich countries but instead will require more inclusive engagement of the east. Many global policy questions will remain the same, e.g. promoting growth in the world economy, but others might change in character, e.g. appropriate political and military intervention. If you are interested in Quah’s paper you can download it by clicking here.

New Zealand has enjoyed a high standard of living and solid economic growth in recent years. However, during this period New Zealand has also exhibited a comparatively low level of productivity growth relative to our OECD peers. Broad-based evidence of this can be seen in New Zealand’s Gross Domestic Product (“GDP”) per capita. This metric measures output per New Zealander and is standardised into US Dollars for all countries. On this metric, New Zealand has consistently trailed the United States, Australia, Canada, Great Britain, France, Japan and the OECD average.

In 2017, New Zealand was ranked 22 of 48 countries surveyed by the OECD, compared with 9th place in 1970 and 20th in 1993. Over the last 50 years the world has seen much stronger growth in exports of manufactured products and slower growth in exports of primary products. And New Zealand’s competitive advantage is still in primary products. We are now on the brink of a technological revolution that will alter the way we live and work. The fourth industrial revolution is all about embracing the digital revolution. Our low productivity levels are a bit of a conundrum and the reasons for this are varied and subjective. Source – ANZ Bank

OECD GDP PER CAPITA (2017)

Source: Organisation for Economic Co-operation and Development (“OECD”)

Whilst the last two might improve the long-term sustainability of the dairy sector they could reduce the profitability of highly indebted farms and their equity buffers.

Banks are closely monitoring about 20% of their dairy farm loans because of concerns about the borrowers’ financial strength. Although a dairy downturn is unlikely to threaten the solvency of the banking system, it does weaken their position if there is another external shock like another GFC. Bank lending in the dairy sector has been consistent over the last few year years but the proportion of loans on principal and interest terms has increased from 6% in January 2017 to 12% in March this year.

Although the average mortgage for most farm types has decreased in dollar value over the past six months, the average mortgage amount increased in the dairy farms – see graph below. The average mortgage for dairy farms is the highest at $5.1 million for the first time since the survey began in August 2015.

The table below shows the average current mortgage by sector over the years shown. Dairy farmers continue to hold the largest proportion of mortgages in excess of $2 million. They are also more likely to have a mortgage over $2 million – 62.5% of all dairy farms – and $20 million – 3.4% of dairy farms.

Traditional economic measures, such as gross domestic product (GDP), productivity and economic growth remain fundamentally important but they’re not the whole picture. We think economics is ultimately about improving people’s living standards but you can’t look at GDP as the indicator to focus on.

US senator Robert F Kennedy pointed out 50 years ago that GDP traditionally measures everything except those things that make life worthwhile.

The introduction of the living standards framework in New Zealand takes into account environmental resources, individual and community assets, ‘social capital’ – which includes cultural norms and how people interact – and human capital, such as people’s health, and their skills and qualifications.

By living standards, the NZ Treasury means more than income; it’s people having greater opportunities, capabilities and incentives to live a life that they value, and that they face fewer obstacles to achieving their goals.

Limitations of GDP as a measure of standard of living – see list below.

Auckland region has the largest regional GDP at $101,370 millionWellington region

($35,603 million), and the Canterbury region ($34,933 million). Economic output in the North Island accounted for over 77 percent of total economic output in New Zeala

Old with the South Island providing the remaining 22.7 percent.
The economy expanded by 6.2 percent over the year in nominal terms (not to be confused with real economic growth of 3.7 percent over the year). The Bay of Plenty region grew the most in percentage terms, expanding by nine percent in nominal ter

ms, followed by the Northland and Waikato regions (8.2 percent each). In contrast, the Wellington region expanded by 4.6 percent over the year.

The region with the highest GDP per capita was the Taranaki region ($70,863), followed by the Wellington region ($69,851), and the Auckland region ($61,924). The region with the lowest GDP per capita was the Gisborne region, at $39,896 for the year ended March 2017.
The following table shows nominal GDP, the annual percentage change, and GDP per capita for the year ended 31 March 2017 by region.

I am quite an avid watcher of the Volvo Ocean Race with the daily race updates and the excellent graphics on their website – currently they are in Auckland before setting sail for Itajaí in Brazil. Most days they have news on the current positions of the yachts and who has made gains and losses in the last 24 hours. A recent race update dealt with the economic impact that the race has had on the Spanish economy and it just happens that I am covering the multiplier with my A2 Economics class.

The Multiplier Explained

Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realise an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

The value of the multiplier can be found by the equation ­1 ÷ (1-MPC)
You can also use the following formula which represents a four sector economy1 ÷ MPS+MRT+MPM

Source: CIE Revision Guide by Susan Grant

Impact of Volvo Ocean Race on Spanish Economy

PriceWaterhouseCoopers (PwC) conducted a study measuring the impact of the Volvo Ocean Race on the Region of Valencia and Spain. Some their findings are:

The impact in the Region of Valencia has grown to 68.6 million euros in GDP and 1,270 full-time equivalent jobs.

Hotels, restaurants and local business were the sectors to benefit the most.

Alicante received 345,602 visitors from October 11 to 22, 2017, (10.3% more than in 2014-15 and 17.6% more than in 2011-12).

The Volvo Ocean Race had a significant positive effect on national tax revenue, adding more than 41 million euros.

The media value directly linked to coverage mentioning the Alicante brand over the period of the race start exceeds 36 million euros.

The Volvo Ocean Race 2017-18 has added 96.2 million euros to the Spanish Gross Domestic Product (GDP), an increase of 7.6% over the 2014-15 edition. The race also generated the equivalent of 1,700 full time jobs in Spain, according to an economic impact study delivered by PriceWaterhouseCoopers (PwC) measuring the impact of the Volvo Ocean Race on the Region of Valencia and Spain.

The impact in the Region of Valencia grew to 68.6 million euros of GDP, a 3.3% increase on the 2014-15 edition. The sectors of activity that benefited the most were local businesses and restaurants, each by more than 10 million euros. In terms of employment, the equivalent of 1,270 full-time jobs were generated, a figure similar to the last edition.

The PwC study estimates a positive effect on tax collection in Spain of more than 41 million euros as a result of an increase in economic activity and employment generated by the Volvo Ocean Race 2017-18.

The actual value of the multiplier is not mentioned in the report but from all accounts the Volvo Ocean Race has had a very positive impact on Valencia.

Determining who owns the land is a necessary step to development and democratisation in Zimbabwe. Nearly all Zimbabweans who benefited from Mr. Mugabe’s land reform policy lack titles, or legal ownership of their property — leaving them at the mercy of the politically powerful. Titles are necessary if landowners are going to secure bank loans and without these loans farmers cannot buy the equipment needed to move on from a subsistence farming environment and their dependence on the government for aid etc.

Government officials, aware of the situation, have urgently started to survey the 6,000 farms that were seized after the fast-track program (where white farmers were forced off their land by the pro-Mugabe ‘Zimbabwe National Liberation War Veterans Association’) in the late 1990’s. This move will hopefully mean that Zimbabwe can now qualify for badly needed loans from international creditors like the International Monetary Fund and the World Bank.

Mr. Chaparadza, the village leader, said that as part of any resolution of the land issue, the new government should compensate white farmers.

“Even if they come back, that’s fine as long as they give us another place,” he said. “We won’t deny them. What we need is only some land where we can survive — and title to the land.’’

Property rights and Hernando de Soto

Peruvian economist Hernando de Soto sees a main obstacle to the development of markets and capitalism within developing countries being linked with the lack of property rights. The result of this is that most people’s resources are commercially and financially invisible. Nobody knows who owns what or where, who is accountable for the performance of obligations, who is responsible for losses and fraud, or what mechanisms are available to enforce payment for services and goods delivered. Consequently, most potential assets in these countries have not been identified or realized; there is little accessible capital, and the exchange economy is constrained and sluggish. However in the West, where property rights and other legal documentation exist, assets take on a role of securing loans and credit for a variety of purposes – building capital with capital.

De Soto estimates that about 85% of urban parcels in Third World and former communist nations, and between 40 and 53 % of rural parcels, are held in such a way that they cannot be used to create capital. The total value of the real estate held but not legally owned by the poor of these countries is at least $9.3 trillion. This is approximately twice as much as the total circulating U.S. money supply and nearly as much as the total value of all the companies listed on the main stock exchanges of the world’s twenty most developed countries. The lack of such an integrated system of property rights in today’s developing nations makes it impossible for the poor to leverage their now informal ownerships into capital (as collateral for credit), which de Soto claims would form the basis for entrepreneurship. However, in reality, it cannot be seen as the panacea. Titling must be followed by a series of politically challenging steps. Improving the efficiency of judicial systems, rewriting bankruptcy codes, restructuring financial market regulations, and similar reforms will involve much more difficult choices by policymakers. Zimbabwe seems to be in need of Hernando de Soto’s ideas. His book The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else is a good read.

Source: New York Times – 20th January 2018

Below is are two great clips from the ‘Commanding Heights’ series with Hernando de Soto talking about property rights. The second one has an interview with a Tanzanian coffee farmer and asks the question – “who owns the land around here?”

Although the paradox of thrift has been a regular part of the CIE A Level syllabus it is has only become more relevant since the Global Financial Crisis (GFC). It has its origins in the 1714 book entitled ‘The Fable of Bees’ by Bernard Mandeville but it was John Maynard Keynes who really popularized this concept during the Great Depression of the 1930’s. Classical economic theory suggests that greater levels of saving will increase the amount of loanable funds in the banks and therefore reduce the cost of money – interest rates. This allows people to put off consumption to a later date thereby avoiding the risk of taking on debt and thereby give people security if their jobs became threatened during a recessionary period

Keynes’ beliefs
Keynes argues that saving was not a virtue from a macroeconomic view as he believed that negative or pessimistic expectations during the Depression would dissuade firms from investing. Cutting the rate of interest is supposed to be the escape route from economic recession: boosting the money supply, increasing demand and thus reducing unemployment. He also suggested that sometimes cutting the rate of interest, even to zero, would not help. People, banks and firms could become so risk averse that they preferred the liquidity of cash to offering credit or using the credit that is on offer. In such circumstances, the economy would be trapped in recession, despite the best efforts of monetary policy makers. The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor.

All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Consequently, monetary policy under these circumstances is futile.

Keynes saw the 1930’s as a time when aggregate demand needed boosting – C+I+G+(X-M) – as the economy was in underemployment equilibrium. With the help of the multiplier, output and employment would increase – GDP. But with increased saving leading to reduced consumption and a fall in aggregate demand, a recession will worsen.

The fact that income must always move to the level where the flows of saving and investment are equal leads to one of the most important paradoxes in economics – the paradox of thrift. Keynes explains how, under certain circumstances, an attempt to increase savings may lead to a fall in total savings. Any attempt to save more which is not matched by an equal willingness to invest more will create a deficiency in demand – leakages (savings) will exceed injections (investment) and income will fall to a new equilibrium. In the graph below, the point of equilibrium is at E where the saving curve SS and investment curve II intersect each other. The level of income at equilibrium is OY and saving and Investment are equal at OH. When the aggregate saving increases, the saving curve shifts upwards from SS to S1S1. The new equilibrium point is E1 with OY1 level of income. Saving and investment are equal at point OT. As the level of saving increases, national income decreased from OY to OY1. Similarly, the volume of saving and investment also declined from OH to OT.

The relevance of the paradox of thrift today is different from that during the Great Depression in the 1930’s. Back then consumers weren’t in as much debt as they are today and the government played a much smaller role in the economy with little or no welfare state to provide automatic stabilizers. Also the financial system wasn’t an interconnected as it is today and the financial engineering that evolved in the 2000’s allowed for the creation of instruments that had no real value to the economy – CDO and CDS. But after the GFC the expectations of consumers became very negative and as workers became fearful of losing their jobs what followed was an increase in savings as they wanted less exposure to debt, which negatively affected consumption.